When calculating debt-to-income ratio for the loan amount you desire, don’t use the wrong figure, or you might be in for a nasty surprise. It happens all the time…
Greg, self-employed in the construction business, reported his income to his loan officer as $95,000/year. With that, he figured he could easily qualify for a $400,000 loan. What he didn’t know was that the underwriter would subtract all the deductions he claimed with the IRS from his income. All construction materials, office expenses, wages paid out, the new truck he purchased–all deducted and all subtracted from his income. With this, his Adjusted Gross Income showed as $29,000, and that is the figure the underwriter used for qualification purposes. Much to his surprise and consternation, Greg’s request for the loan he wanted was denied.
The Adjusted Gross Income figure is the one you need to go by for self-employed income. Yes, depreciation and a few other things can be added back, but for simplicity, look at your Adjusted Gross Income.
Typically, self-employed folks hire good accountants to squeeze every legal deduction they can out of their income. That is fine. But realize you can’t have it both ways. You can’t get out of paying taxes on $95K and then turn around and claim $95K as your income when you want a mortgage.
The Take-Away here is to plan ahead. If you want to buy a house in the next year, speak with your tax preparer about making sure your income will qualify. And whatever you do, don’t go house shopping until you have a valid Pre-Approval Letter in hand that verifies the purchase price you qualify for.